INVESTIGATION OF FOREIGN INSTITUTION INVESTMENT IN INDIA

Abstract

The economic landscape of India underwent a paradigm change when the economy was liberalized in 1991. It also laid the foundation for a strong regulatory network. India witnessed stellar economic performance through the period 2005-09 .This was manifested through an average 8.5 – 9 percent GDP growth rates, rising domestic savings and investment levels and the amount of foreign capital flowing into the country. Foreign investments can be in the form of Foreign Institutional Investor (“FII”), Foreign Direct Investment – (“FDI”), Foreign Venture Capital Investor (“FVCI”) Foreign Institutional Investors have been a major source of funds into the Indian Capital Markets in the past few years. As per the RBI, Report on Currency & Finance (2003-04), since 1991 there has been continuous move towards the integration of the Indian economy with world economy. Since then the regulations with regard to FIIs investment has become more liberal. As a result of abolishment of barriers to capital inflows in the form of FIIs investment, India attracted huge amount of foreign capital particularly from developed countries. The cumulative net investment by FIIs in Indian stock market crossed Rs. 25000 crore in January 2013(RBI Bulletin). International capital inflows have both positive as well as negative impact on the health of the recipient economy. On the positive side, these capital inflows raise the level of economic development by augmenting the domestic investment and widen financial intermediation. But these capital inflows also pose several threats to the domestic economic and financial system of the recipient economy like inflation, appreciation in exchange rate, overheating of the economy and possibility of sudden withdrawal. FIIs investment is volatile by nature and is often termed as „hot money‟. The hot money character of FIIs investment adds to the possibilities of „contagion‟. Delhi School of Management, DTU vi The dissertation, examines causal relation between FIIs, stock market return and other macroeconomics variables such as exchange rate, index of industrial production (IIP), wholesale price index (WPI), interest rate and money supply in India using “Granger‟s Causality Test” to find out the possible relation between FII and these economic indicators of India. Also, in the light of huge and growing FIIs investment inflows to India, appropriate policy formulation is the need of the hour which will help in reducing the impact of possible threats and maximizing the benefits from the same to enhance economic and financial development. This in turn calls for the need to estimate statistically the determinants of FIIs investment to understand deeply the factors that boost FII inflows into the country. Therefore, an effort has been made to empirically investigate the determinants of foreign institutional investment in India. After a thorough analysis, it has been found that FII has bidirectional causality with Sensex, Exchange Rate and crude oil rate. Granger‟s Causality Test shows risk in US market is affecting FII in India. FII is having a causal effect on the WPI, IIP which is also exhibited by their strong positive correlation. The main determinants of FII in India found by regression analysis are Lag variable of FII, Sensex, Standard deviation in Sensex, Crude Oil Rate, WPI, MIBOR Rate, Political Environment in India. Thus, all these variables need to be controlled appropriately in the policies of the Indian government to harness the best from foreign institutional fund flow from abroad.